Which Assets Can Be Priced by the CAPM Formula?

Abstract

We determine the general solution for the semi-equilibrium prices of primitive securities in the formula for the capital asset pricing model (CAPM). Furthermore, considering the clearing condition of the total market value of risky assets, we determine the equilibrium solution to the CAPM market, which reveals the overall thinking in equilibrium pricing. We use a numerical example to illustrate that the CAPM equilibrium does not exclude arbitrage opportunities. In addition, we show that the CAPM formula can only be used to price marketable (within the market payoff space) assets, because beta pricing is a manifestation of the law of asset portfolio in the CAPM market, that is, beta pricing is based on the prices of primitive securities to compute the linear pricing of the asset portfolio in the market. Therefore, the various existing applications of the CAPM formula need to be re-examined.

Keywords: CAPM, Semi-equilibrium Price, Quasi-equilibrium Price, Arbitrage Opportunity, Beta Pricing

JEL Classification: G12